NY futures surged higher this week, with May gaining 253 points to close at 66.22 cents, while December advanced 142 points to close at 65.96 cents.

Current crop futures rallied to their highest level since late September after technical buy signals invited new spec buying. On Monday the May contract broke out of its ‘flag’ formation and then proceeded to cross over the important 200-day moving average, which triggered buy stops and attracted new players to the game. Defensive moves by the owners of short May call positions may have added additional fuel to the fire.

However, based on the muted reaction in the cash market, we feel that this latest advance is primarily the result of structural and technical factors related to current crop futures. As we have pointed out repeatedly, the US is basically sold out of tenderable grades, which puts anyone who is still short May or July futures in a vulnerable situation.

When there is a lack of deliverable grades, shorts won’t be able to offset their position with cotton or even threaten to do so by increasing the certified stock. Although the certified stock has gone up to 37’000 bales as of this morning, it still only represents 370 futures contracts, which pales in comparison to the 268’000 bales or 2’680 contracts we had in place a year ago.

This means that the shorts will likely be forced to either buy out or roll out of their position. However, when new spec longs are rushing into the market because the chart inspires them to do so, there needs to be someone on the other side willing to go short. But with the trade already shorter than it needs to be at this point and with speculators typically not interested in betting against the prevailing trend, the market is compelled to move higher in search of potential sellers.

US export sales of a combined 80’100 running bales net as well as shipments of 452’100 running bales continued to reduce available supplies further last week, bringing total commitments for the current season to 10.6 million statistical bales, of which 6.6 million bales have so far been exported. Similar to last week there were 16 different markets chasing after US cotton last week, with small cancellations showing up in 10 markets. Again, we feel that most of these cancellations result from a lack of suitable cotton to ship.

Today’s USDA supply/demand report contained no big surprises, as global production, mill use and ending stocks were basically left unchanged. However, there were some minor changes that added up to a slightly positive sentiment in our opinion. Chinese and Vietnamese imports were each increased by 0.2 million bales to 7.5 million and 4.1 million bales, respectively, while Indian exports were lowered by 0.3 million to just 3.9 million bales. That bears some importance because India has currently the largest amount of exportable cotton available, not counting China of course, which operates on a different price plateau.

Rest of the world (ROW) ending stocks are expected to drop by 0.15 million to 44.95 million bales, thanks to slightly stronger Chinese imports. Although global ending stocks of 110.1 million are scarily large, enough to cover global mill use of 111.0 million bales for an entire year, 59 percent of these stocks are located in China and are not readily accessible to the ROW because they are currently withheld by the government and much too expensive. A further 13 percent are in India, where prices are competitive but the government exercises control over the release of these stocks.

Therefore, when we look beyond China and India, we notice that available inventories have not really changed that much over the last five seasons, ranging between 27.6 and 31.7 million bales, with this year’s number at 30.4 million bales. Of course we can’t just think these Chinese and Indian inventories away, but the fact that they are not being dumped on the world market has allowed prices of other origins to remain fairly well supported.

So where do we go from here? The market’s latest up move has been impressive, since it occurred in rising volume and open interest, which tells us that this is not simply some short covering, but that new bets are being placed. Open interest has gone up by about 15’000 contracts over the last four sessions to 195’000 contracts overall, even though the May contract is in its liquidation phase. With longs and shorts both digging in, it will be interesting to see who ultimately keeps the upper hand. What speaks against the shorts is that they don’t have the intimidation factor this time around, i.e. a large certified stock with which to frighten the longs.

However, if the shorts manage to hold their ground long enough they may once again be able to tire out the longs, similar to what has happened in February. Many of these spec longs are momentum traders and in order to maintain upside momentum a constant supply of buying is required. More often than not it is short covering that feeds a bull market in its final phase. Therefore, if the shorts hang in there they may stall momentum, reverse the trend and flush out some of the longs.

If momentum stalls we may see a pullback towards the 63-64 cents area, where the trade would likely support the market. On the other hand, if trade shorts get cold feet and start covering, the market might challenge the 70 cents level. While we have no firm opinion on May’s next move, we feel that new crop is starting to run into strong resistance from grower hedging and will find it difficult to advance any further from here.